A repurchase option or deal is referred to as a ‘REPO.’ It is a monetary instrument used by the RBI to enable commercial banks to borrow money against collateral such as government bonds and treasury bills when they need funds. The Reserve Bank of India (RBI) charges a certain rate of interest to commercial banks when lending money. This rate is known as the repo rate.

The current repo rate will adjust following RBI policies. In the event of a cash shortage, commercial lenders may approach the RBI to obtain funds for a set period by depositing government bonds as collateral. The RBI receives interest from these financial institutions based on the existing repo rate. They will repurchase bonds from RBI at the end of the period by repaying a fixed sum.

The repo rate is a key instrument used by the central bank to monitor increasing inflation and sustain market liquidity. As a result, a decision on the repo rate is made based on the state of the economy. The RBI Governor chairs the Monetary Policy Council, which makes decisions on the current repo rate.

The repo rate is used by the RBI to monitor the amount of money in the economy. It aids in the attainment of peace. The cost of credit for commercial banks is affected by changes in the repo rate. This has a bearing on commercial banks’ retail lending practices, resulting in changes in home loan interest rates, bank deposit rates, and so on.

Repo Rate Function

On the principal money lent from the financial institution, one must pay interest. The cost of credit is a general term for this. Banks and financial institutions borrow capital from the Reserve Bank of India in exchange for qualifying securities that they supply to the central bank in a cash pinch.

The repo rate is the interest rate at which the RBI lends money to commercial banks and financial institutions. The term “repurchase option” or “repurchase arrangement” refers to an agreement between banks and the Reserve Bank of India (RBI) in which the latter lends money to financial institutions in exchange for security.

Components of Repo Rate

The criteria on which the RBI decides to conduct the contract with the banks are as follows:

Cash Reverse – As a precautionary measure, banks borrow money from the RBI to retain liquidity or cash reserves.

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Collateral and Securities – The Reserve Bank of India accepts gold, shares, and other forms of leverage.

Short Term Borrowing – RBI lends money for a brief period, up to an overnight period, during which banks buy back their deposited securities at a fixed amount.

Hedging and Leveraging – RBI aims to hedge and leverage by buying securities and bonds from the banks and provide cash to them in return for the collateral deposited.

Preventing economy squeeze – Depending on inflation, the central bank raises or lowers the Repo limit. As a result, it helps to regulate the economy by keeping inflation under control.

Repo Rate Economical Impact

Increased Inflation 

During periods of high inflation, the RBI makes concerted efforts to reduce the flow of capital in the economy. Growing the repo rate is one way to do this. Borrowing becomes prohibitively expensive for firms and sectors, slowing demand and capital flow in the economy. As a result, it harms economic development and tends to keep inflation under check.

The rise in Liquidity of the Market

When the RBI has to inject funds into the economy, on the other hand, it lowers the repo rate. As a result, borrowing capital for various investment purposes is less expensive for companies and sectors. It further expands the total capital balance in the economy. This, in turn, increases the economy’s growth rate.

Reverse Repo Rate

The Reverse Repo Rate is a tool for absorbing market liquidity and limiting investors’ borrowing capacity. When there is surplus liquidity in the economy, the RBI borrows money from banks at a reverse repo rate. Banks profit from that when they get returns on their central bank deposits. The RBI raises the reverse repo when the economy’s inflation rate is high. It allows banks to deposit more money with the RBI to gain better returns on their surplus capital.

Difference Between Repo Rate and Reverse Repo Rate

Repo Rate Reverse Repo Rate
It is the pace at which the Reserve Bank of India loans money to banks. The pace at which the RBI borrows money from banks is known as the repo rate.
It is greater than the rate of the reverse repo. It is a much lower rate than the repo.
It is for controlling inflation and deficiency of funds. It is for managing the cash flow.
It involves sales of securities that would be repurchased in the future. It involves the transfer of money from an account to another.

Other forms of lending and borrowing under the repo rate

Overnight Repo

Overnight Repo refers to a day-long repo trade. Banks sell shares to the RBI in exchange for currency, which they then repurchase the next day, returning the money to the central bank.

Term Repo

A term repo is a loan that lasts more than one day. Term repo or floating rate term repo usually lasts 7 days, 14 days, or 28 days. The word repo auction is usually announced by the RBI when banks need funds for more than a day.

The Current Impact of Repo Rate

According to changing macroeconomic factors, the RBI keeps changing the repo rate and the reverse repo rate. When the RBI changes the interest rates, it affects all segments of the economy, though in different ways. As a result of the rate hike, certain segments will benefit and others will lose money.

The repo rate was recently reduced by 25 basis points to 5.15 percent from 5.75 percent. In the same vein, the reverse repo rate was cut from 5.5 percent to 4.9 percent. Changes in repo rates may significantly affect large-ticket loans like home loans. A decrease in repo rates is to aim at bringing in growth and boosting economic development in the region. Inflation will be stabilized as consumers borrow more from banks.

A drop in the repo rate could prompt banks to lower their lending rates. This could be advantageous to holders with supermarket loans. To lower loan EMIs, however, the lender must lower its base lending rate. According to RBI guidance, banks and financial firms must pass on the benefits of interest rate reductions to customers as soon as possible.

Repo rate – FAQs

Q1. How does Repo Rate Impact a Home loan rate?

Home loan rates are directly linked to the RBI repo rate, any change in the repo rate has a significant impact on the real estate sector. Commercial banks and mortgage finance companies do not set their interest rates on home loans; instead, they are aligned to an external benchmark. As a result, any adjustment on the repo rate affects the interest rate on a home loan.

Q2. What is the impact of the Repo Rate hike?

Since the current MCLR is connected to the repo rate, any rise in the repo rate would cause the MCLR to rise. Borrowers of adjustable-rate home loans, personal loans, and corporate loans will see their interest rates rise as a result of this. Due to the higher interest rate, demand for credit facilities (loans) will decline as the Repo Rate rises. This will help the RBI and the government in their efforts to keep inflation under check.

Q3. How does repo rate cut translate into lower interest rates?

Banks’ cost of funding decreases as the RBI lowers the repo rate. As a result, banks can offer lower-cost loans to their customers. The repo rate is commonly used by banks to calculate deposit rates, loan rates, and base rates.

Q4. What does the repo rate mean for borrowers?

With a rate hike of 25-75 basis points, EMIs on home loans are expected to rise by 15 to 50 per lakh of the loan volume. The same is valid for all other types of loan holders, whether they are taking out a personal loan, a car loan, a company loan, or a real estate loan.

Q5. What does the repo rate mean for depositors?

Due to a strong inflow of deposits and lower loan offtake, banks and NBFCs have been positioned to have excess funds.